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Financial System •Space for visual (size 24)

In India
Course Outcome
CO Title Level
Number
CO1 Remember
Students will have a thorough knowledge about
the financial system and its functioning
Will be covered in this
CO2 Understand lecture
Students will be able to understand the
emerging role and regulations relating to the
financial services in India

CO3 Students will be able to know the services Understand

provided by the Indian market
 Functions of Financial System
• Saving Function:
An important function of a financial system is to mobilize savings and channelize them
into productive activities. It is through financial system, savings are transformed into
investments.
• Liquidity Function:
• The most important function of a financial system is to provide money and monetary
assets for the production of goods and services.
• Monetary assets are those assets which can be converted into cash or money easily
without loss of value. All activities in a financial system are related to liquidity-either
provision of liquidity or trading in liquidity.
 Functions of Financial System
• Payment Function:
• The financial system offers a very convenient mode of payment for goods and services.
The cheque system and credit card system are the easiest methods of payment in the
economy. The cost and time of transactions is considerably reduced.
• Risk Function:
• The financial markets provide protection against life, health and income risks. These
guarantees are accomplished through the sale of life, health insurance and property
insurance policies.
Functions of Financial System
• Information Function: A financial system makes available price-
related information. This is a valuable help to those who need to take
economic and financial decisions. Financial markets disseminate
information for enabling participants to develop an informed opinion
about investment, disinvestment, reinvestment or holding a particular
asset.
• Transfer Function: A financial system provides a mechanism for the
transfer of the resources across geographic boundaries.
Development of Financial System in India
To clearly understand the evolution of financial system in india,we will
divide the history in phases.

PHASES
• Upto 1951 Pvt. Sector
• 1951 to 1990 Public Sector
• Early Ninties Privatisation
• Present Status Globalisation
At the time of Independence in 1947
• No strong financial institutional mechanism.
• Absence of issuing institutions and non-participation of intermediary FIs
• The industrial sector also had no access to the savings of the community.
• The capital market was very primitive and shy.
• The private as well as the unorganized sector played a key role in the provision
of ‘liquidity’.
Indian Financial System – An Overview

Pre 1951
1. Control of Money Lenders
2. No proper Laws and regulations.
3. No Regulatory Bodies
4. Hardly any industrialization
5. Banks – Traditional lenders for Trade and that too short term
6. Main concentration on Traditional Agriculture
7. Narrow industrial securities market
8. Absence of intermediatory institutions in long-term financing of industry
9. Industry had limited access to outside saving/resources
 Indian Financial System – An Overview

1951 onwards : 5 years PLAN commenced.

PVT. SECTORS TO PUBLIC SECTOR – MIXED ECONOMY
• With the adoption of mixed economy,
• the Govt. started creating new FIs to supply finance both for agricultural and industrial development
• Started NATIONALIZING SOME IMPORTANT FI,s so that the flow of the finance might be in the right
direction.
MAIN Elements of Financial Organizations
i. Public ownership of Financial Institution
ii. Strengthening of Institutional Structure
iii. Protection to Investors
iv. Participation in Corporate Management
v. Organizational Deficiencies.
Nationalization of Financial Institutions
• RBI was established as a private institution in 1935 and nationalized in 1948.
• 1956: Nationalization of the Imperial Bank of India by renaming it as SBI.
• 1956: 245 Life Insurance Companies were brought under Government control by
merging all of them into a single corporation called LIC India.
• 1969: 14 major banks with Deposits of over Rs. 50 Crs. nationalised
• 1980: Again, 6 banks were nationalized
• 1972: (General Insurance Corp. GIC by New India, Oriental, united and National
• Thus, the important financial institutions were brought under public control.
Starting of Unit Trust of India
• Another landmark, to strengthen our system and to supply institutional credit to
industries.
• The UTI was established in 1964 as a public sector institution to collect the
savings of the people and make them available for productive ventures.
• Its investment is confined to both corporate and non-corporate sectors. It has
established the following subsidiaries:
(i) The UTI Bank Ltd., in April 1994.
(ii) The UTI Investor Service Ltd., to act as UTI’s own Registrar and Transfer
agency.
(iii) The UTI Security Exchange Ltd.
•1982: the National Bank for Agriculture and Rural Development (NABARD) -
Institution for Financing Agriculture
•1982: The Export and Import Bank of India (EXIM Bank) was set up as Institution
for Foreign Trade
•1987: Stock Holding Corporation of India Ltd. (SHCIL) was set up to tone up the
stock and capital markets in India.
•1988: The National Housing Bank (NHB) has been set up as Institution for Housing
Finance
•1990: The Small Industries Development Bank of India (SIDBI) was set up as a
wholly owned subsidiary of IDBI.
SEBI
• Securities and exchange Board of India (SEBI) was first established in the
year 1988 as a non-statutory body for regulating the, securities market.
• It became an autonomous body by The Government of India on 12 April
1992 and given statutory powers in 1992 with SEBI Act 1992 being passed
by the Indian Parliament.
• SEBI has its headquarters at the business district of Bandra
Complex in Mumbai, and has
• Northern, Eastern, Southern and Western Regional Offices in New
Delhi, Kolkata, Chennai and Ahmedabad respectively.
 Indian Financial System – An Overview POST 1990

INDUSTRIAL DEVELOPMENT
• Rise & Growth of Service Sector industries.
• Reliance & Dependence on technology.
• E-mail & mobile made sea-change in communication, data collection etc.
• Computerization – a catch phrase and inevitable need of an hour.
• Dependent on Capital Market rather than only Debts dependancy.
• Scalability of operations through globally competitive size.
• Broad basing of Board.
• Professional Management.
Indian Financial System – An Overview
POST 1990

• Promoting consultancy services like

• Project Counseling,
• Merchant Banking,
• New Issues Management,
• Market related activities,
• Merger & Acquisitions, sponsoring Mutual Funds, Wealth Management, Sales &
Services of insurance (both life & non-life) products etc.
• New Private Sector Banks (AXIS, YES, HDFC, KOTAK MAHINDRA etc.)
• CAMELS’ Rating (C-Capital Adequacy, A-Asset Quality, M-Management, E-Earning, L-
Liquidity, & S-Systems & controls).
 Indian Financial System – An Overview
POST 1990
Mutual Funds
 Bifurcation of UTI and UTI (AMC) put under SEBI.
• Banks, Broking Houses, Finance Companies Insurance Companies, Pvt. Sector in
Foreign collaboration, FII and Merchant Banks
set up Mutual Funds with a varieties of schemes.
• Helps small investors in big way
• Backbone of Capital Markets
Mutual Funds
• AIG, Baroda Pioneer, Birla Sunlife, Canara Robeco, DBS Chola, Fortis, Franklin, HSBC, HDFC, ICICI
Prudential, IDFC, ING, JM, Kotak, LIC, Magnum, Mirae, Morgan, Quantum, Reliance, Religare, Sahara,
Sundaram BNP, Tata Tourus, UTI etc.
• Mutual Funds Investment Schemes (over 1000 in Nos.)

Equity Balanced Funds

Equity Diversified Hybrid – Equity Oriented
Equity Index Hybrid – Debt Oriented
Equity Tax Planning Hybrid – Asset Allocation
Equity Banking
Equity FMCG Bond Funds
Equity Pharma Debt Medium Term/Short Term
Equity Technology Debt Medium Term/Short Term Institutional
Equity Speciality Hybrid Monthly Income
Cash Funds
Indian Financial System – An Overview
Securities/Capital Market

Primary Market
- Phenominal increase in number of investors.

- New intermediatories i.e. Merchant Bankers, Underwriters, Bankers to Issue,

Registrar to Issue, Portfolio Managers, Depositories, FIIs, Custodians, Rating
Agencies, etc. are playing important role.

- FIIs are allowed to invest & participate in public issues of Debt & Equities within
sectoral limits fixed by the Govt.
Indian Financial System – An Overview

Secondary Market
- Over 90% Securities Dematerialised.

- Depository Act 1996; 2 Depositories NSDL & CDSL.

- Settlement Cycle reduced from 15 days to T + 2.

- Clearing & Settlement by Clearing Corp.

- Securities related derivatives introduced.

- Future, Option, Arbitrage, Hedging permitted.

 Indian Financial System – An Overview
Money Market
- Money Market Mutual Funds came up
- Call/Notice Market
- Treasury Bills Market
- Commercial Paper Market (CP)
- Certificate of Deposit Market (CD)
Deficiencies of Indian Financial system
• Lack of Coordination between different FIs
• Monopolistic market structure
• Dominance of development banks in industrial
financing
• Inactive and Erratic Capital Market
• Imprudent Financial Practice
 Lack of Co-ordination between different
Financial Institutions

• As there is multiplicity of institutions in the Indian financial system, there is lack of co-ordination in the
working of these institutions.
• There are a large number of financial intermediaries.
• Most of the vital financial institutions are owned by the Government.
• At the same time, the Government is also the controlling authority of these institutions.
• In these circumstances, the problem of co-ordination arises.
Monopolistic Market Structures

• In India some financial institutions are so large that they have created a
monopolistic market structures in the financial system.
• For instance the entire life insurance business is in the hands of LIC.
• The UTI has more or less monopolized the mutual fund industry.
• lead to inefficiency in their working or mismanagement or lack of effort in
mobilizing savings of the public and so on.
• Ultimately it would retard the development of the financial system of the country
itself.
Dominance of Development Banks in Industrial Financing

• The development banks occupying an important place in the capital market.

• These development banks act as distributive agencies only, since, they derive
most of their funds, from their sponsors.
• As such, they fail to mobilize the savings of the public.
• This would be a serious bottleneck which stands in the way of the growth of an
efficient financial system in the country.
• For industries abroad, institutional finance has been a result of
institutionalization of personal savings through media like banks, LIC, pension
and provident funds, unit trusts and so on. But they play a less significant role in
Indian financial system, as far as industrial financing is concerned.
Inactive and Erratic Capital Market

• The important function of any capital market is to promote economic

development through mobilization of savings and their distribution to productive
ventures.
• As far as industrial finance in India is concerned, corporate customers are able to
raise their financial resources through development banks. So, they need not go
to the capital market.
• Moreover, they don’t resort to capital market since it is very erratic and inactive.
Investors too prefer investments in physical assets to investments in financial
assets.
• The weakness of the capital market is a serious problem in our financial system.
Imprudent Financial Practice
• The dominance of development banks has developed imprudent financial
practice among corporate customers.
• The development banks provide most of the funds in the form of term loans.
• This predominance of debt capital has made the capital structure of the
borrowing concerns uneven and lopsided.
• To make maters worse, when corporate enterprises face any financial crises,
these financial institutions permit a greater use of debt than a warranted.
• It is against the traditional concept of a sound capital structure.
Absence of Integration
• The Indian money market is broadly divided into the Organized and Unorganized
Sectors.
• The former comprises the legal financial institutions backed by the RBI.
• The unorganized statement of it includes various institutions such as indigenous
bankers, village money lenders, traders, etc.
• There is lack of proper integration between these two segments.
Multiple rate of interest
• In the Indian financial market, especially the banks, there exists too many rates
of interests.
• These rates vary for lending, borrowing, government activities, etc.
• Many rates of interests create confusion among the investors.
Shortage of Investment Instruments :
• In the Indian money market, various investment instruments such as Treasury
Bills, Commercial Bills, Certificate of Deposits, Commercial Papers, etc. are used.
• But taking into account the size of the population and market these instruments
are inadequate.
Lack of Organized Banking System
• In India even through we have a big network of commercial banks,
• still the banking system suffers from major weaknesses such as the NPA, huge
losses, poor efficiency.
• The absence of the organized banking system is major problem for Indian money
market.
• However, in recent times all efforts have been taken to activate the
capital market. Integration is also taking place between different
financial institutions. For instance, the Unit Linked Insurance Schemes
of the UTI are being offered to the public in collaboration with the
LIC. Similarly the refinance and rediscounting facilities provided by
the IDBI aim at integration. Thus, the Indian financial system has
become a developed one.
Savings-investment relationship

• To attain economic development, a country needs more investment

and production.
• financial institutions, induce the public to save by offering attractive
interest rates.
• These savings are channelized by lending to various business
concerns which are involved in production and distribution.
Financial systems help in growth of capital market

• Every business requires two types of capital namely, fixed capital and
working capital.
• Fixed capital is raised through capital market by the issue of
debentures and shares.
• Public and other financial institutions invest in them in order to get a
good return with minimized risks.
• Working capital is getting through money market, where short-term
loans could be raised by the businessmen through the issue of various
credit instruments such as bills, promissory notes, etc.
Foreign exchange market
It enables the
•exporters and importers to receive and raise the funds for settling
transactions.
•banks to borrow from and lend to different types of customers in
various foreign currencies.
•Banks to invest their short term idle funds to earn profits.
•Governments can meet their foreign exchange requirements through
this market.
Government Securities market
• State and central governments to raise both short-term and long-
term funds through
• the issue of bills and bonds which carry attractive rates of interest
along with tax concessions.
• Thus, the capital market, money market along with foreign exchange
market and government securities market –
• enable businessmen, industrialists as well as governments to meet
their credit requirements.
Infrastructure and growth
• The financial services play a crucial role by providing funds for the
growth of infrastructure industries.
• For a long time, infrastructure industries were started only by the
government in India.
• But now, with the policy of economic liberalization, more private
sector industries have come forward to start infrastructure industry.
• The Development Banks and the Merchant banks help in raising
capital for these industries.
Development of trade
• The financial system helps in the promotion of both domestic and
foreign trade.
• The financial institutions finance traders and the financial market
helps in discounting financial instruments such as bills.
• Foreign trade is promoted due to per-shipment and post-shipment
finance by commercial banks.
• They also issue Letter of Credit in favor of the importer.
• Thus, the precious foreign exchange is earned by the country because
of the presence of financial system
Employment growth is boosted by financial
system
• Financial system provides working capital due to which production
increases,
• resulting in generating more employment opportunities.
• Service sector such as sales, marketing, advertisement, etc., also pick
up, leading to more employment opportunities.
• Various financial services such as leasing, factoring, merchant
banking, etc., will also generate more employment.
• The growth of trade in the country.
• Financing by Venture capital
Venture capital

• The economic development of a country will be rapid when more

ventures are promoted which require modern technology and
venture capital.
• Venture capital cannot be provided by individual companies as it
involves more risks.
• It is only through financial system, more financial institutions will
contribute a part of their investable funds for the promotion of new
ventures.
Financial system ensures balanced growth
• Economic development requires a balanced growth which means
growth in all the sectors simultaneously.
• Primary sector, secondary sector and tertiary sector require adequate
funds for their growth.
• available funds will be distributed to all the sectors in such a manner,
that there will be a balanced growth in industries, agriculture and
service sectors.
Fiscal discipline and control of economy
It is through the financial system, that the government can :
•create a congenial business atmosphere so that neither too much of
inflation nor depression is experienced.
•raise adequate resources to meet its financial commitments so that
economic development is not hampered.
•regulate the financial system through suitable legislation so that
unwanted or speculative transactions could be avoided.
•The growth of black money could also be minimized.
Financial system’s role in balanced
regional development
Through the financial system,
•backward areas could be developed by providing various concessions.
•balanced development throughout the country and this will mitigate
political or any other kind of disturbances in the country.
•It will also check migration of rural population towards towns and
cities.
• Attracting foreign capital
• A dynamic capital market is capable of attracting funds both from domestic
and abroad.
• With more capital, investment will expand and this will speed up the
economic development of a country.
• Economic Integration
• Financial systems of different countries are capable of promoting economic
integration.
• This means that in all those countries, there will be common economic
policies, such as common investment, trade, commerce, commercial law,
employment legislation etc.
Recent developments of Indian financial system

• In a number of sectors the government plays the role of regulator.

• Ministry of Finance, Government of India looks after financial sector in India.
• The reforms proposed by expert committees require legislative changes, leading
India’s Ministry of Finance to set up the Financial Sector Legislative Reforms
Commission to rewrite the laws.
• the commission submitted the proposed Indian Financial Code.
• It replaces most existing Indian financial laws.
• It outlines the powers of agencies that regulate the financial sector
• Indian stock market is also comparable to the international stock markets in
terms of turnover ratio.
• Presently, India has third largest investor base in the world.
• Indian Stock market trading and settlement system are of world class.
• India has one of the world's lowest transaction costs based on screen-based
transactions and paperless trading.
The top 5 developments in Indian financial system in 2016.
1. Withdrawal of legal tender status for Rs 500 and Rs 1000 notes
2. Setting up of the monetary policy committee
3. Passage of the goods and services tax bill
4. Passage of the insolvency and bankruptcy code
5. Thrust towards digitization of government payments
1. Withdrawal of legal tender status for Rs 500
and Rs 1000 notes

“To break the grip of corruption and black money, we have decided that the five
hundred rupee and thousand rupee currency notes presently in use will no longer
be legal tender from midnight tonight that is 8th November 2016….”
•With these words the Indian Prime Minister in one stroke announced the
withdrawal of what constituted 86% of Indian currency in circulation at that point
in time.
2. Setting up of the monetary policy committee

• October 4th, 2016 marked the first time that

• a committee, rather than one person, until then the RBI Governor, would decide
the policy interest rates in the economy.
• Entrusted with the task of fixing the benchmark policy rate (repo rate) required
to contain inflation within the specified target level,
• the Monetary Policy Committee was set-up with six members – three
nominated from the Central Government and three from the Reserve Bank of
India, with the RBI Governor getting the casting vote in case of a tie.
3. Passage of the goods and services tax (GST)
bill
• Aimed at doing away with a host of Central and State taxes and ushering in a one
tax regime for the entire country, both the Houses of Parliament passed the
Goods & Services Tax Bill in August 2016, with the President giving his assent in
September.
• GST would lead to a uniform consumption-based tax structure across the land for
almost all goods and services and the government has set a deadline of April 1,
2017 to roll this out.
• GST implementation would integrate the economy and provide for a common
national market that enables businesses to leverage a simplified tax regime
4. Passage of the insolvency and bankruptcy
code
• In May 2016, both Houses of the Parliament passed the Insolvency and
Bankruptcy Code that set in motion a national bankruptcy law to deal with
insolvencies.
• The Central Government in December notified the final regulations related to
- the insolvency resolution process under the Liquidation and Bankruptcy Code
2016, paving way for the operationalization of the 10-member Liquidation and
Bankruptcy Board (IBBI).
5. Thrust towards digitization of government
payments

• The year 2016 saw extensive measures to incentivize greater implementation of

digital payments with an all-round push by different Ministries and controllers.
• For instance, the Ministry of Electronics and Information Technology laid out
Procedures for Acceptance of Electronic Payments and Receipts in November
2016 that covers a time bound process for the integration of digital payments
and receipts connecting all Government divisions.
• It has set an ambitious deadline of 31 December 2016 by which 90% of outflows
and receipts of all Government Divisions are to be made online.
 References
• M.Y. Khan (2006), Financial Services, Tata McGraw-Hill Publishing Co.
Ltd., New Delhi.
• L. M. Bhole (2007), Financial Institutions and Markets, Tata McGraw-
Hill Publishing Co. Ltd., New Delhi.
• V. K. Bhalla: Management of Financial Services, Anmol Publications.
• V. A. Avdhani: Marketing of Financial Services, Himalaya Publishing
House.
• Bansal, L.K., Merchant Banking and Financial Services, Tata McGraw
Hill.
• http://www.economicsdiscussion.net/india/money-market/money-ma
rket-in-india-features- structure-constituents-participants-and-defects
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